AAPL: Merrill Cuts Target to $780, Trims Margin Estimate

By Tiernan Ray

Merrill Lynch’s Scott Craig this morning reiterated a Buy rating on shares of Apple (AAPL) while cutting his price target to $780 from $840, after trimming estimates for this year and next based on his expectation for fewer iPhone units sold than he’d previously expected, “continued weak U.S. demand overall,” pressure on Apple’s gross margin, and the global macroeconomic situation.

In the past two major iPhone cycles (iPhone 3G in 2008 and iPhone 4 in 2010), Apple shares underperformed the S&P 500 at the beginning of the cycle by as much as 37pts/9pts, respectively, mostly due to margin headwinds and initial supply constraints. However, continued strength in iPhone demand and margin tailwinds from improving production yields led the stock to reverse the trend by the end of the product cycle, with Apple shares outperforming the S&P 500 by as much as ~11pts/~42pts before the new products were announced (iPhone 3GS and iPhone 4S). Given solid demand for the latest product lineup, we expect similar dynamics to play out in this cycle, leading to a stock outperformance after the recent 20%+ correction.

Craig’s new price target is based on a multiple of 12 times calendar 2013 EPS of $56.25, after giving consideration for $128 per share in cash.

Multiple new product introductions will push Apple’s gross profit margin to 39.4% this quarter, he thinks, higher than the 36% Apple has projected. For the full fiscal year 2013 ending in September, he is modeling 42.9%, down from a 43.5% he’d previously modeled, though above the 42.4% peak that Apple had previously hit in 2011.

Based on that, Craig cut his year forecast to $197.05 billion and $52.45 in EPS, down from $199.6 billion and $54.30. That is still above the Street consensus for $193.2 billion and $50.09 per share, he notes.

Craig cut his iPhone unit estimate for this fiscal year to 170.5 million units from a prior 174.7 million units, but believes data from the supply chain suggest demand is still strong. Although iPhone margins are lower than in past, he thinks sales of iPhone this year will help Apple’s gross margin:

In the iPhone 4 cycle, which we view as the last major iPhone revision and most similar to the current iPhone 5 cycle, we saw similar margin headwinds at the beginning of that cycle (C3Q10). However, Apple’s margins rebounded back to the previous peak three quarters later (C2Q11) on higher volume and production yield improvements. Apple’s margins expanded further in the following year and achieved the new gross margin peak in C1Q12, as the following iPhone 4S involved minimal design changes. We assume overall iPhone gross margin of < 48% in C4Q12, below ~53% in C3Q12 and the historical iPhone margin range of 49-58%. Our forecast is driven by ~45% gross margin for the iPhone 5 (~40mn units in C4Q12) and ~57% gross margin for the iPhone 4/4S (~10mn units). Even at the beginning of a product cycle, we believe the iPhone gross margin is still above Apple’s other hardware products, and a higher iPhone revenue mix in C4Q12 should be positive for Apple’s overall gross margin. We forecast iPhone revenue to account for 56% of total revenue in C4Q12 vs. 48% in C3Q12 and 43% in C3Q10, which was the beginning of the iPhone 4 cycle. After multiple quarters of severe declines, NAND pricing has been stabilizing quarter-to-date (first half of November MLC contract pricing on average flattish vs. a month ago and up 15% vs. 3 months ago, but down ~20% YTD and down ~25% Y/Y). However, a favorable iPhone mix toward higher-end iPhones in C4Q12 (i.e. higher memory iPhones), which we view as typical at the beginning of an Apple iPhone product cycle, coupled with attractive incremental profit per GB for Apple (i.e. incremental revenue of $100 for extra 16GB, but far less procurement costs), should be positive. Using data from Strategy Analytics, we estimate average NAND content per iPhone could improve to ~23GB in C4Q12 from ~21GB in C3Q12 and ~19GB in C3Q10 (recall that Apple started offering 64GB SKUs with the iPhone 4S).

Craig offers a chart of Apple’s historical and projected gross margin trends over the course of iPhone introductions:

Apple shares today are up $29.25, or almost 6%, at $556.93, certainly prompted in part by my colleague Kopin Tan‘s cover piece on Apple and Samsung Electronics (005930KS), in which Kopin argues Apple is the better stock buy between the two.

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There are 16 comments

NOVEMBER 19, 2012 1:48 P.M.

No Jeff wrote:

Let's see, one up day, 45 down days... $780? U gotta be kidding. Case study is why the little guy should never listen to Wall Street, or if you do listen, do the opposite!

NOVEMBER 19, 2012 1:55 P.M.

Yes Jeff wrote:

What goes down must come up, Jeff. It's a fundamental law of the share price of great companies.

NOVEMBER 19, 2012 2:03 P.M.

Ed wrote:

Nice article. Shows your true colors!

NOVEMBER 19, 2012 2:07 P.M.

JD wrote:

You also have to take into consideration that if Apple launches the ITV and it's relating ecosystem that will function with the TV, that creates an entriely new revenue (revenues I shoud say) stream for the company. Also, keep in mind that Apple is projected to establish a partnership with China Moblie the 2nd half of 2013 and this partnership will complete the Tri-Fecta of Chinese Mobile carriers that distributes Apple products! In my opinion, 2013 will be Apple's Renaissance year and change the game in the TV Market!

NOVEMBER 19, 2012 2:16 P.M.

John wrote:

Funny how Apple is up 30 points today after losing 200 in 6 weekls and you have to print a BS Negative headline about a PT cut! Get a life.

NOVEMBER 19, 2012 2:17 P.M.

Anonymous wrote:

I'm glad I didn't sell everything on thursday.

NOVEMBER 19, 2012 2:32 P.M.

Moe Skoshi wrote:

Who cares if Apple's target price is lowered? As a shareholder, I'd rather be holding a $780 a share stock than a $560 a share stock. At least Apple got a little closer to Google today for a change. Apple fell so damn far it's pathetic. Google is always screwing Apple shareholders and Google needs to be taken down a peg.

NOVEMBER 19, 2012 2:53 P.M.

merechina wrote:

Prostitutes always act secioritos afterwords.

NOVEMBER 19, 2012 3:55 P.M.

Anonymous wrote:

what a great guy Scott is. His numbers look accurate and based on quite a serious scientifically derived calculus.
Now... we just need him to learn he's supposed to forecast things BEFORE they happen not after the 200 point drop.

NOVEMBER 19, 2012 4:08 P.M.

No Jeff wrote:

One day wonder. My technical guru neighbor confirmed this afternoon today that aapl will "drift" back into line over the next two weeks and confirmed the $425 price target. Move today is nothing compared to the $200 price drop, $36 bucks up, chump change people and NOT a trend.

All in on my leveraged put strategy and luvin' it, off to cruizze in the new car smell of my very special candy appl read BMW!

NOVEMBER 19, 2012 4:10 P.M.

Casey Serin wrote:

I agree with No Jeff, this move today was a one-off. The name of the game in stock markets is "Short", non Fat aapl Latte!

NOVEMBER 19, 2012 4:32 P.M.

@ No Jeff and Casey Serin wrote:

And if you're wrong. Can you go away forever and ever? Hmm. Take your family with you. Pack the trunk of your car. And just drive. Drive. One direction only. Hope to never hear from you again. Okay sport. If you're wrong. Thank you.

NOVEMBER 19, 2012 4:56 P.M.

Rob wrote:

Keep it in your pants. Apple drops 20 tomorrow

NOVEMBER 19, 2012 6:41 P.M.

Paulo Lin wrote:

For sure Apple will drop tomorrow!

NOVEMBER 19, 2012 8:07 P.M.

Anonymous wrote:

you missed reporting on the iCLoud outage, Tiernan --- yhoo.it/TcoDqY

NOVEMBER 20, 2012 5:32 P.M.

Paul wrote:

LOL. Write about one analyst cutting his target, which actually isn't to that bad a level, and the immature iDiots come out of the woodwork to whine.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.